Electing S Corporation Status for a Limited Liability Company

An S corp election for an LLC, or limited liability company, is an option when a business owner prefers to form a limited liability corporation but wants the beneficial tax treatment of an S corporation. Otherwise, an LLC is treated as a partnership by the IRS and is subject to self-employment tax on income from the business. While an S corporation is still treated as a pass-through entity, the income is taxed at the lower corporate rate. Electing S corporation tax treatment for your LLC is often the best option for active businesses or those who are subject to high payroll taxes. 

Both an S corporation and an LLC offer limited liability protection. This means the owners' personal assets are protected from business debts and legal judgments. An LLC is easier to manage and administer than an S corporation and offers more flexibility in distributing profits and losses to the owners. However, an S corporation allows owners to be paid either through distributions or with salaried wages. This entity also provides taxation benefits over an LLC.

Choosing whether to form an LLC or an S corporation requires determining the priorities for your business.

Benefits of Forming an LLC

An LLC is a state-governed business entity that combines the limited liability of a corporation with the tax and operational benefits of a general partnership or sole proprietorship. As with a corporation, an owner's personal liability only extends to his or her investment in the business. By default, an LLC is treated as a pass-through taxation entity. This means the owners report business profits and losses on their individual tax returns. This prevents the double taxation experienced by corporation owners. An LLC is not recognized as a separate taxation entity by the IRS.

An LLC is easier to manage than a corporation since it is subject to fewer required:

  • Filings
  • Forms
  • Formal meetings
  • Record submissions 

An LLC is also less costly to start than a corporation. Unlike with a corporation, profit-sharing is not restricted for an LLC. This means you can distribute income without considering capital contribution percentages. 

LLC owners receive self-employment income, taxed at 15.3 percent for Social Security and Medicare. A single-member LLC is taxed as a sole proprietorship by default, while a multimember LLC is treated as a partnership by default. If you prefer to be taxed as a corporation, file Form 8832 (Entity Classification Election). You can then opt to be taxed by an S corporation by filing Election by a Small Business Corporation, Form 2553.

Benefits of Forming an S Corporation

If you elect to create an S corporation, all income, losses, deductions, and credits from the business will be reported on your federal tax return and taxed at your individual rate. This minimizes your business's tax liability, since only wages paid to owners and employees are subject to Medicare and Social Security Tax (FICA). Other earnings are considered dividends. Another benefit of an S corporation is the limited liability it provides its owners. 

However, an S corporation must be based in the U.S. and have no more than 100 shareholders, excluding family members of each owner, who together count as one shareholder. An S corporation may not have the following as shareholders:

  • Corporations
  • Partnerships
  • Nonresident aliens

However, estates, individuals, and certain types of trusts are permitted. An S corporation can issue a single class of stock, which can contain both nonvoting and voting shares. Some types of financial institutions, international sales corporations, and insurance companies are not eligible to form S corporations. 

S corporations are also subject to complicated administrative requirements, including:

  • Additional filings and forms
  • Formal meetings
  • Official recordkeeping, which includes meeting minutes, bylaws, and written resolutions 

Unlike in an LLC, S corporation profits must be distributed proportionally to each member's ownership share. However, the ability to pay owners regular wages provides some flexibility and income distribution.

Combining the Benefits of an S Corporation and LLC

You can establish an LLC as the legal entity for your business but opt to be treated as an S corporation for taxation. This combines ease of administration with the ability to minimize your business's tax liability.

If you need help with electing S corporation status for your LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb